State Tax Residency – How Serious Is It?

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Since many of our clients are multi-state professionals, we go out of our way to stress how states are extremely aggressive in residency audits and how serious the state tax returns are.

Among reminders are

  1. Do not use assignment addresses on any legal document
  2. Do not use assignment addresses on tax returns
  3. Avoid buying cars out of state unless you can tag it to your own
  4. Keep a copy of your contract in your car in case you are stopped

The article linked below highlights the tools that state revenue agencies will use to conduct “Residency” audits. Ignore the political aspect of the article, and focus on this quote:

New York’s success rate on audits can be attributed not only to the traditional methods of investigation like going through an individual’s credit card bills, but also to new high-tech tools that include tracking phone records, social media, and even veterinary and dentist records, …..

Here is the article: New York Residency Audits

First Wave of State Tax Return Changes

tax return.jpgThe Federal tax overhaul changed the landscape for many state returns as they pull for items on the federal return. NY will now allow State and Local Tax (SALT) deductions in full on the NY return even if the taxpayer takes the standard deduction on the Federal return

In addition, Alimony and Moving expenses will continue to be allowed at the state level.

The Oregon Trail Leads to a Cliff –

Two recent tax related cases were decided and happened to be printed on the same newswire. One a Federal case that was on appeal and the other an Oregon state case. Both involved taxpayers claiming expenses for the use of an RV for business related activity while on the road. The Federal case made the IRS happy, the Oregon case …… well …… the OR state attorneys missed the boat or forgot to ask the IRS.

A little background is necessary before appreciating this.

First, the IRS, following tax court precedent, does not allow a taxpayer to depreciate an RV when it is also used as a residence more than 14 days. This is well established due to that fact that an RV is very difficult to partition into a home office deduction that requires exclusive use of an area of a residence for business.

Second, Oregon tax code specifically mirrors Federal tax law except where the Oregon legislature has decided to deviate. Outside of these exceptions, what the IRS does, Oregon does as well – or is supposed to.

Enter the two cases which are provided for your reading. The Federal case was decided right along the lines of the previous Federal cases addressing RV usage – in fact this one was an appeal that was upheld. Nothing grand there. However, the Oregon case went down the wrong trail. The attorney for the taxpayer in the Oregon case argued that the RV was deductible since it was a condition of employment for the taxpayer to maintain his own lodging at various jobsites. The Oregon attorney handling the case sort of took the bait and argued against the condition of employment and did not even mention (or was not aware) the Federal precedent. Well, if procuring lodging near a worksite is a condition of employment and you buy an RV to satisfy that, based on that condition alone, you have a major depreciation deduction. That is where the Internal Revenue Code adds another hurdle preventing one from deducting depreciation for a structure that passes the test of a dwelling, owned by the taxpayer, if they use it for more than 14 days, unless they can carve out exclusive business use of the dwelling from the personal use area.  Can’t do that in an RV.

The Oregon attorney didn’t even mention the Federal case, not attempted to argue the code section that supported it. Even the judge didn’t think about Federal precedent, but happily set a precedent for Oregon RV owners that want to use RVs for their lodging at worksites.

I called the attorney’s office in Oregon and they said they would probably issue a “non-acquiescence” which means they just don’t agree with the court. The case is allowed an appeal so we will wait to see. I have even provided another Federal case that decided the same 🙂

Federal Case from 2014

Oregon Case

Federal Case in Appeals

State Tax Residency Cases-Indiana Style

The title is a bit misleading and purposeful as this really doesn’t add to the body of knowledge for state tax residency rules. However, it reinforces the basis by which most states determine tax residency.

State tax residency is important as the state where an individual keeps their legal domicile is the state that has a right to tax global/worldwide income earned by the taxpayer. The more common term to describe this relationship is a Permanent Residence. This is different from the concept of a Tax Home that determines from where an individual has travel related expenses that are either deductible or that they can receive reimbursements for on tax-free basis. .

Many of our clients deal with Permanent Residence issues either because they are moving, staying too long in one state or the state wants to take an aggressive tone toward some relationship that the client has to a state.

In these 2 Indiana state tax cases, one positive for the taxpayer and the other negative, the same common benchmarks were used to determine whether the taxpayers had a domicile in Indiana. These benchmarks are common to most states:

1) Purchasing or renting residential property
2) Registering to vote
3) Seeking elective office
4) Filing a resident state income tax return or complying with the homestead laws of a state
5) Receiving public assistance
6) Titling and registering a motor vehicle (Drivers Licenses)
7) Preparing a new last will and testament which includes the state of domicile.

Item 6 is very important as you will see in the two cases that are linked below:

In the first case, entitled “negative”, the taxpayer was a physician that moved to Louisiana to take a permanent job, however, he continued to use his ex-spouses address in Indiana for license, registration and insurance purposes.  Most states treat residency similar to a flight on an airplane-when you take off, the wheels no longer touch the ground and when you land the wheels touch the ground in the new location. When one moves and changes their domicile they are expected to sever all residential ties so that their affairs no longer touch the old state. Additionally they are expected to establish ties in the new state to replace the ones that were severed in the old state. You cannot just take off, you have to land as well. Similar to this case, the taxpayer took off but never landed as he continued to maintain his Indiana residential and legal ties.

2016-indiana-residence-case-negative

In the second case that was decided for the taxpayer, a couple moved from Florida to Indiana, however the wife came first and the husband came a year later. Generally, most states expect spouses to move together which is most likely the reason that Indiana Department of Revenue expected the couple to file joint returns as residents Indiana in the wife’s first year of residence. However, in this case, the husband remained in Florida working at his full-time job and did not change his legal ties  – his driver’s license and car registration,  until he moved to Indiana. The wife was correctly judged to be a part year resident of Indiana in year one, and the husband a part year resident of Indiana beginning in year two.

2016-indiana-residence-case-positive

Take Away

One of the most common misconceptions among mobile professionals is that they are only taxed in whatever state they work. That is not the case. An individual is taxed on their worldwide income by the state in which they are domiciled-where they maintain their permanent residence. They are also taxed by the work state on income earned within their borders. However, to relieve the possibility of double taxation, the home state will generally credit the taxpayer for taxes paid to other states on the same income.

The final take away is simply the power of the state to impose tax on all income an individual earns if they continue to maintain their legal ties to that state. Simply taking another job in another state doesn’t change the equation. The ties to the old state must be severed and at the same time, ties to the new state must be established.